Arsene Taxand - Real Estate

Reform of the 3% annual tax on real property -

European court judges have finally got the better of the French annual tax on real property (commonly called the “3% tax”), as the text providing for its application was drafted prior to 2008, which have held that to be partly in contradiction with the principle of the free circulation of capital. Foreign investors were daunted by the tax’s complexity and tax practitioners have long been criticizing it for its iniquity. The lawmaker needed to react in order to adapt the tax to EU norms. This has now been done and the amended finance bill for 2007 has changed the provisions applying to this tax from January 1, 2008 onwards. The lawmaker has also taken this opportunity to make noteworthy amendments that will satisfy some but may be seen as a cause of concern by others. In their guideline 7 Q-1-08 of August 7, 2008, the French tax authorities have recently commented on the new provisions and the main innovations are described below.

Besides bringing the tax into compliance with EU norms (I), the new rules provide both for enlargement of the scope of application of the tax to include certain entities which were previously exempt (II) but also for a widening of the cases for exemption which, although they do not cover all the issues raised, help to simplify the management of this tax and demonstrate a certain pragmatism (III).

It should be noted that the 3% tax was originally a mechanism aimed at combating attempts to avoid French wealth tax. French or foreign individuals with real estate assets in France might have been tempted to hold their real estate assets through the intermediary of one or several French or foreign companies in order to make it difficult or even impossible for the French tax authorities to identify the actual owners of such assets. In order to combat tax evasion, the lawmaker introduced the 3% tax in 1982. This tax consists, in principle, of giving both French and foreign real estate companies the right to choose between two possible courses of action: either the company has to pay a tax every year equal to 3% of the market value of the French real estate assets held directly or indirectly by the company or the company has to disclose the identity of its shareholders. This measure, which was applied to all the companies in the chain of shareholdings, was aimed at discovering the identity of the individuals who were the ultimate shareholders in order to levy French wealth tax, where applicable. As the 3% tax is higher than the marginal tax rate of French wealth tax applicable, companies therefore had a strong incentive to cooperate to avoid having to pay this costly tax. For further details on the scope of application of the 3% tax, we suggest you consult our other tax alerts on this topic.

1. Bringing the tax into compliance with EU rules
The new rules provide that, like companies with their registered headquarters in France, companies with their registered headquarters in a European Union Member State can now benefit from the exemption from the 3% tax either by filing an annual declaration (tax form No. 2746) which discloses the shareholders’ identity and provides other information relating to the real estate assets or by undertaking to provide such information to the French tax authorities on their request.

Furthermore, the benefit of the 3% tax exemption is extended under the same conditions for companies located outside the European Union provided that the country where their headquarters is registered has concluded with France a convention on mutual administrative assistance to combat fraud and tax evasion or a tax convention providing for an equal treatment provision.

Naturally, if neither of these provisions exists between France and the country concerned, the foreign company will not be entitled to an exemption from this tax even if it decides to disclose the identity of its sharehold ers.

In their guideline, the French tax authorities have updated the list of countries with which France has entered into a convention on mutual administrative assistance to combat fraud and tax evasion and also the list of countries with which France has entered into a tax treaty including a clause providing for equal treatment.

2. Enlargement of the scope of application of the tax to include entities with no legal personality
In addition to legal entities, the 3% tax has now been extended to cover legal entities without legal personality such as “bodies, organizations, trusts or comparable institutions” according to the provisions of Article 990 D of the French Tax Code.

The scope of application of the tax is therefore intended to be very broad but should primarily concern, in practice, trusts and investment funds, which are major players in the real estate field.

With regard to a trust, a type of structure that is often used to manage personal real estate assets, the tax authorities specify that the filing obligations will be borne by the trustee, as the trust’s legal representative. If the trustee wishes to benefit from either of the exemptions (inasmuch as the trust is entitled to benefit from such an exemption), he will either have to declare the settlor in the case of a revocable trust or the beneficiary or beneficiaries in the case of an irrevocable trust. If the trustee does not want (or is unable) to benefit from an exemption from the tax, the trustee must then proceed to pay the tax.

In the case of investment funds (and subject to the specific provisions applicable to French real estate investment funds and their foreign equivalents), the tax authorities specify that the filing and payment obligations may be handled by the fund management company which may naturally apply for an exemption, where applicable.


3. Widening of the cases for exemption
We only mention below the most important measures aimed at rationalizing and simplifying the 3% tax:

• The obligation to disclose or to undertake to disclose the shareholders’ identity only concerns shareholders holding over 1% of the share capital of the entity concerned. This measure should make it possible to greatly simplify the declarations filed by investment funds which sometimes have several thousands of unit holders;

• Entities that directly or indirectly hold a percentage of real estate assets with a value of 100,000 euros or less or that represent 5% at most of the total value of such real estate assets are now exempt from the 3% tax. The tax authorities specify that these two thresholds are not cumulative and are alternatives and that the 5% threshold applies whatever the market value of the underlying assets. Furthermore, these thresholds must be applied asset by asset, which will enable an entity which holds interests in several different real estate companies to qualify for an exemption from the tax inasmuch as its interests are limited to 5%;

• Companies whose shares, equity interests and other rights are regularly traded in significant proportions on a regulated stock market are exempt from the 3% tax. The tax authorities specify that, in the European Union, these are markets approved by Member States in accordance with Article 16 of Directive 93/22/EC, as amended, and which are included on the list of regulated markets prepared and updated by the European Commission. With regard to companies listed on a market outside the European Union, the tax authorities specify that it is necessary to check whether or not such market is governed by rules similar to those applying to regulated markets. For this purpose, the authorities list a certain number of criteria for comparison and also state what they mean by the reference to regular trading in significant proportions contained in their guideline;

• An exemption from the 3% tax is also allowed for legal entity subsidiaries that are wholly-owned directly or indirectly by a company whose shares, equity interests and other rights are traded regularly in significant proportions on a regulated market;

• SPPICAVs (investment companies with variable capital investing primarily in real estate) and FPIs (real estate investment funds) available to the public at large and governed by the provisions of Articles L 214-89 et seq. of the French Monetary and Financial Code are also exempt from the 3% tax. In the light of the large number of shareholders or unit holders, the lawmaker wanted to avoid these fund managers from encountering administrative difficulties which are almost impossible to resolve. However, this automatic exemption does not apply to funds set up by a limited number of institutional investors (applying the RFA procedure providing for simplified rules of functioning), which will have to comply with the necessary filing obligations in order to qualify for an exemption from the 3% tax. In the case of foreign legal entities, the automatic exemption will apply to companies that are subject to regulations equivalent to those that apply to SPPICAVs and FPIs. In their guideline, the tax authorities specify the criteria which lead them to consider that the foreign entity is subject to equivalent regulations;

• It is now possible to apply for only a partial exemption from the tax. In this regard, in the event that a company cannot (or is unwilling to) disclose the identity of some of its shareholders, the company may benefit from a partial exemption from the tax with regard to the proportion of the company’s shares held by shareholders whose identity has been disclosed by the company. This measure is of significant interest for investment funds where some shareholders are absolutely determined to remain anonymous, which could indirectly penalize shareholders who agree to disclose their identity or lead to complex rules for managing the fund.

Due to the late publication of this guideline, the tax authorities state that annual declarations required in order to benefit from an exemption from the tax for 2008, which should normally have been sent to the tax authorities by May 16, 2008, can be sent in by September 15, 2008 at the latest.

Finally, it should be noted that, in the case of an exemption from the 3% tax obtained via an undertaking, the amended finance bill for 2007 has slightly altered the list of information that the entity must undertake to provide. The fact that it is no longer necessary to attach proof of the shareholder’s tax residence if his identity is disclosed is a favorable measure. However, the need to disclose the market value of the real estate assets from now on is a more restrictive provision.

Due to these changes, the tax authorities consider that it is necessary for all companies that made an undertaking prior to January 1, 2008 to now make a new undertaking, including the new information they are required to provide. Each investor’s situation with regard to the 3% tax will therefore have to be re-examined and new undertakings will have to be made where applicable. Due to the significant constraints involved, the tax authorities have stated that they will accept undertakings made up until December 31, 2009.

Even though certain aspects of the reform may be seen as a disappointment since the simplifications introduced do not go far enough, it should be noted that the mechanism has been considerably rethought and that the new system makes it possible to refocus on the original main aim of this tax: to counter attempts to evade French wealth tax.




François Lugand
Tax lawyer and partner

Franck Llinas
Tax lawyer

Arsene Taxand, October 2008